Thursday, 30 April 2015

There is some evidence that the Conservatives have finally
found a scare story that works. We probably will not know how large or long
lasting it will be until after the election. However, as scare stories are
generally myths, and I now have a professional interest in mythmaking, I thought it would be worth asking why this one has stuck whereas earlier attempts have failed.
[1]

Here were some earlier but unsuccessful attempts.

1)‘Labour will bankrupt the economy, again’. Given
mediamacro, this should have worked. But I suspect this line was ruined when
Cameron started to promise to tax less and spend more
and reduce the deficit. You cannot base your fiscal policy on home economics
and then ignore the household accounts.

2)‘Labour will put up your taxes’ flopped, perhaps
because voters didn’t mind too much if this helps save the NHS. A smaller state
is just not popular, which is probably one reason
why they had to make so much of deficit reduction.

3)The ‘Miliband looks funny’ strategy fell apart when
people realised he was rather better than much of the press made out. The
problem here was that there was no half-truth to build a myth upon (beside a
rather dark one), but the Conservatives believed their own propaganda.

So why has the Lab+SNP=chaos line worked? A myth it certainly is.
If you want chaos, see what will happen to the Conservative party during the EU
referendum. One scenario I have not seen discussed is that a new Con/LibDem
coalition breaks apart after the referendum, either because Cameron fails to
recommend staying in, and/or because large numbers of Conservative MPs defect to UKIP, which makes the coalition dependent on their support.

With my mediamacro experience, I can think of three reasons why
this myth has stuck. First a successful myth has to be based on a half-truth,
and the half-truth is that the SNP would have some influence on any Labour
government. Not much, because to vote down a Labour government would be a huge gamble for the SNP. Their support in
Scotland could disappear overnight if they could be charged with letting a
Conservative government back in without due cause. But clearly there would be
some influence, which is only right in a democracy.

Second, the non-partisan media finds it difficult to counter a
myth when no major political party is calling it a myth, particularly during an
election. The SNP have encouraged the myth: some would unkindly say because
they want a Conservative government, but even if that is not true they want to
talk up the influence they would have on Labour. Labour itself does not want to
promote the idea that they could happily work with the SNP because they in turn
want to scare former Labour Scottish voters from voting SNP. With no political
party challenging the chaos myth, the media finds it very difficult to do so
off its own bat. A few journalists like Philip Stephens in the FT can add some reality, but if politicians are not
being challenged repeatedly on the news, then there is little to counter the
formidable power of the right wing press.

Third, this is new territory, with few reference points, so
people cannot use their own experience of similar situations in the past. The
parallel with austerity would be the Eurozone crisis.

But before I convince myself, there may be something less myth
like and more basic going on here: pure and simple nationalism. Although many
on the left would like to believe that the Scottish independence referendum
marked a new engagement with politics away from the Westminster elite, it could also just be another example of the
political power of nationalism. And if nationalism can have so much force north
of the border, it is not surprising that there should not be at least some echo
of this in England. English feelings of resentment and unfairness might be
perfectly justified, but their monetary and political importance is tiny
compared to the huge differences between the political parties on other issues. But nationalism does not respect that kind of calculus.

So maybe this all has nothing to do with chaos theory, but is
simply about a more basic strategy: divide and rule.

[1] There has been some criticism within the Conservative party
about the negative character of their campaign. Why not focus on the positive
achievements of the last five years? What is not clear to me is whether this
was ever a viable strategy. In my own sphere I can think of one positive
achievement, which was setting up the OBR, but I suspect I attach more weight
to that than the average voter.

Wednesday, 29 April 2015

The story presented in much of the UK media is simple and
intuitive. The previous government messed up: they spent too much, and it left
the UK economy on the brink of financial meltdown. The coalition came to the
rescue: clearing up the mess was tough at first, but now it is all coming good.

In previous posts I have shown that this is almost complete
fiction. The increase in the government’s budget deficit under Labour was all
about the recession, which in turn was created by the global financial crisis. There
was no prospect of a UK financial crisis in 2010, which meant that austerity
was not something the government was forced to undertake. Reducing the deficit
could have been left until the recovery was secure (and crucially interest
rates had risen above their lower bound), but the coalition chose to do
otherwise. As a result they delayed the recovery by three years, at great
cost. Even since 2013 we have simply seen a return to normal growth rates:
there has been no catching up of lost ground. In that sense growth under the
coalition hardly deserves the term recovery, and we have seen an unprecedented
lack of growth in living standards. Productivity growth has been non-existent,
yet the government has feted the employment growth that is its counterpart.

The government’s claims of macroeconomic success can therefore
be dismissed without saying a word about the nature of the GDP growth that has
taken place. But what growth there has been is itself worryingly unbalanced, as
a new report discussed here sets out. Growth is too
dependent on consumption, there is not enough investment, and the current
account deficit is very large.

A large part of the media sees their role as supporting the
government’s line, however far from the truth it may be. For whatever reason,
most of the remaining media has bought this line, and failed to expose it as
fiction. Even a headline in the Guardian yesterday talked about “rip-roaring
growth rates of 2013 and 2014” when growth in GDP per head in those years was at best just average, and growth in income
per head non-existent.

It is still commonplace to hear media commentators say that the
economy is doing great, and ask why the government is not reaping the benefit
in terms of political support. In truth the puzzle is the opposite - given how
poor economic performance under the coalition has been, and that this poor performance has hit most people in their
pockets, the real puzzle is why so many people think the government is
economically competent. And the answer to that puzzle in turn lies in the myths
that mediamacro has allowed to go unchallenged. Perhaps the latest
growth figures might begin to dent them, but a remarkable feature of these
myths is that they seem impervious to actual data.

I coined the term mediamacro because I obviously find it
strange that public discourse on the macroeconomic fortunes of the UK economy
seems so different from what the data and simple economics would suggest. For
once I can be the one handed economist that Truman demanded,
because the evidence is so clear and the economics (what little there is) so uncontentious. But mediamacro
has implications well beyond macroeconomics. If the media has been capable of
distorting reality by so much for so long in this case, are there other areas
where it has done the same, and what does that tell us about the health of our
democracy?

Tuesday, 28 April 2015

Thanks to Google I get to see when someone writes about me, so
I read an article by Ryan Bourne in CityAM. It basically
says that while Keynesians keep saying that their models have been vindicated
by the economic effects of austerity (but economists always disagree with each other blah blah), they
have lost the political debate. In the case of the UK, even Labour is no longer
Keynesian. While Labour are planning hardly any additional austerity, but the
Conservatives are planning a lot, according to Mr. Bourne Labour are not
justifying this less contractionary stance in Keynesian terms.

For the sake of argument, let us assume that Mr. Bourne is
correct about Labour. We also need to ignore the SNP of course. Suppose Mr. Bourne
is right that Keynesians have lost the political argument. This line is not
new, with more authoritative newspapers having said similar things in the past. What should
seem very strange is that Mr. Bourne and others do not appear to view this as a cause
for concern.

It is a concern because Keynesian economics is taught to pretty
well every student who ever studies economics anywhere in the world, and
usually not as just one competing theory among many but as how the world works.
Nor is it the case that academic macroeconomists are hopeless divided over the issue: a
large majority on both sides of the Atlantic agree that fiscal austerity/stimulus reduces/enhances
growth when monetary policy cannot offset its impact. Most major central banks
use Keynesian theory as a basis for their monetary policy decisions. The
reason for all this is that the evidence overwhelmingly backs Keynesian ideas,
including that fiscal contraction tends to reduce output.

Given all this, if all three major UK political parties are ignoring Keynesian economics that would be a real worry. Now this might not worry Mr. Bourne if he was just one of
these politicos for whom politics creates its own truth and that is all that
matters. However he is in fact head of public policy at an outfit called the Institute of Economic
Affairs. Perhaps, given the level of debate about fiscal policy in the media nowadays, that would be economic affairs of the more homely kind.

We have had the slowest recovery from a recession almost since
records began, and a large part of that is down to the sharp fiscal contraction
that the coalition government chose to undertake, despite there being no market
pressure to do so. But, supporters of the coalition might say, employment
growth has been very strong. This is an argument that is almost as ludicrous as
the 2013 recovery vindicates austerity idea, but there is still a half-truth
behind it. [1]

To see why it is ludicrous, you just need to note that - by
definition - labour productivity is output divided by employment, and that over
the medium to long run living standards are largely determined by productivity.
So to try and take credit for strong employment growth despite lack of output growth is to take credit for poor
productivity growth (or, in the UK case, the virtual absence of productivity growth over
the last five years). Which is very close to wanting to take credit for the
lack of growth in real incomes.

In short, it is output that matters, not employment. Employment
growth due to output growth is good, but employment growth without output
growth is not. To extol employment growth without output growth could be described as a luddite point of view!

The half-truth concerns the distributional impact of a
recession. On average we are worse off in a recession, but those that really
feel it are workers that lose their jobs. For a given level of output in a
recession, it would be better if the pain was evenly spread through cuts in
living standards and little increase in unemployment. So, if (and this if is critical)
productivity growth just paused during a recession, but then made up for all
the lost ground afterwards, that would probably be a good thing.

So, in that very specific sense, lack of productivity growth
might be a good thing given the lack of a recovery, on the assumption that we get it all back again later. However I
doubt very much whether the government would want to take credit for stagnant
productivity during their term of office for two reasons. First, it probably
has very little to do with them, and rather more to do with the flexible labour
markets encouraged by their predecessors. Second, there are very strong doubts
that we will get back all the lost productivity growth: the OBR is assuming we
get back virtually none.

So to claim credit for strong employment growth is the same as
claiming credit for poor productivity, and it is hypocritical to try to do the
first and not the second. [2] Given that many economists argue that poor productivity growth is our
number one problem right now, implicitly claiming credit for creating the problem in the first place is
somewhat bizarre.

[1] There are many reasons to doubt the ‘quality’ of the employment
growth (see for example David Blanchflower (pdf)), but that is not my concern here, except
in so far as that helps explain lack of productivity.

[2] Although this highly unusual lack of productivity growth
after a recession pretty well coincides with the period of the coalition
government, it is far from clear whether there is a connection or not. If poor
productivity is down to firms using workers rather than capital because the recession
plus austerity has pushed down wages, then there is a connection between
austerity and poor productivity. However other explanations are equally possible, which is why it is
called the UK productivity puzzle.

Monday, 27 April 2015

There has been some talk recently about what is wrong with
macroeconomics. (Jérémie Cohen-Setton has a good summary, although non-economists are allowed
to do a bit of skipping. And yes, I am a little late on this - cannot think why.) Of course there is always talk of this
kind - it just ebbs and flows. But I think this recent upsurge has missed an
important point (which, as is often the case, is an elaboration of a point already made by Paul Krugman). .

Many of the complaints about macro are along the lines that it
needs more models involving X. Now X can be many things: a financial sector,
nonlinearities, multiple equilibria etc. Yet as anyone who is involved in
modern macro knows, pretty well whatever X is, there are models that have those
things. If you want chapter and verse on this, see Tony Yates (as in here). Indeed, one of the characteristics of
modern macro, as opposed to the stuff I dimly remember from my youth, is the
huge variety of approaches on offer. In that sense, academic macro is flourishing.

Does that mean the critics are wrong? Not necessarily. I think
what is missing in this discussion is the concept of a received wisdom which
non-academics (including politicians and civil servants) can readily access.
There may be plenty of models which allow for recessions to persist
indefinitely, for example, but the received wisdom might still be that
recessions are temporary affairs caused by price stickiness and therefore the
economy always ‘self-corrects’. So the criticism should not be that there is no
analysis of X, but that X is not part of the received wisdom.

A related point can be made about the financial crisis. It is
not the case that we need a whole new set of economic tools to understand
financial crises: it turns out we had most of the tools already. (Most, not all
- see for example the reference here to the Bank of England’s work on
networks). The problem was more the received wisdom, which was that the
problems that the financial system had shown in the past had been solved, and
so we could just ignore them. Once that received wisdom was shattered, there
were plenty of tools in the toolbox to analyse what had gone wrong.

So where exactly is this received wisdom of which I speak? An
obvious place to look is the textbooks we use. However the pace at which the
subject moves (often propelled by events) means they are far from a perfect
source, and they are not that accessible for non-economists. In the sciences
the received wisdom is normally common knowledge among academics; in
macroeconomics less so. One place you will clearly find it is in institutions
that have to use that knowledge to do their job. So there is clearly a received
wisdom about monetary policy, and you will find it among the economists in
central banks.

That is why I’m happy to talk about the New Keynesian model
being the consensus model as far as business cycles are concerned, because that
is the case in central banks. Others have
disagreed with this consensus label, but often because they are thinking about
the lack of consensus among the wider academic community. Sometimes you can go
further still, and argue that the received wisdom in an institution can be
found quite precisely in the model that they use to forecast and do policy
analysis.

I think this way of thinking can help us understand one reason
why governments across the globe have so easily failed by implementing premature austerity. In
the past, and perhaps if they did not have an independent central bank, they would
probably have had in house capacity (and perhaps a model) to know what damage
austerity would cause. But with the widespread adoption of independent central
banks, that capacity has faded. Finance ministries have lost that expertise,
and become much more about expenditure control. Independent central banks had
the knowledge to know that fiscal austerity would be damaging, but for a variety of reasons
typically chose not to express it.

Without a clear sense of received wisdom, policymakers are at
the mercy of policy entrepreneurs or ideology-based think
tanks, and may be unaware that the line they are being sold might be viewed as
rubbish by many academics. That of course is putting it very charitably: the
problem may be that the policymaker is fully aware of what they are doing, but know
they can get away with it because the media is unaware of any received wisdom,
or may find it difficult to express. Whichever it is, it suggests one
particular route by which independent central banks are part of the reason for
the persistence of the Great Recession. By locating the received wisdom about
fiscal policy in an institution that was unwilling to express this wisdom, that
wisdom was effectively lost.

It was perhaps inevitable that when output did start growing
again in 2013, everyone would breathe a huge sigh of relief, and extol what was
happening. But that time has passed, and yet mediamacro - with few exceptions -
has not told people the truth about the recovery. What they have not said is
that the recovery does not really deserve that name. This picture tells you
why.

The first point is to stop talking about GDP, and start talking
about GDP per head. An economy that grows because it has more people in it is
not obviously a good or bad thing, and from the government’s point of view -
given its (missed) net migration target - it represents a failure. It is GDP
per head that determines living standards, which is what matters.

Now if you were on a journey, and in one part of your journey
you were delayed by 10 minutes because of a traffic jam, you would be relieved
when that jam came to an end, but would you call moving again a recovery?
Surely you would only talk about a recovery if you made up for some of that
lost time. As the chart shows, we have failed as yet to make up for any of the
ground lost not just in the 2009 recession, but also ground lost as a result of
fiscal austerity in 2010 and 2011.

So we have not really seen a recovery. Maybe the pessimists are
right, and we will never recover any of that lost output, but still you do not
call it a recovery.

I can put it another way. Quarterly growth in GDP per head
since the beginning of 2013 has averaged about 2% at an annual rate. That is below the average growth rate since
1955. A recovery from a deep recession would have growth rates well above the long term average.

So current growth is unexceptional, and nothing to write home
about. The half-truth here is that growth elsewhere has also been poor, but
largely because
other countries have also implemented premature fiscal austerity. (In terms of
GDP per head, both the US and Japan have
done better than the UK since the recession.) But even GDP per head may be
giving us an overoptimistic picture about average living standards. I’m going
to break my one chart rule for this series to add this from the ONS. It plots
GDP per head, and Net National Disposable Income (NNDI). The first measures production per head before depreciation,
whereas NNDI measures income per head
after depreciation.

NNDI has not increased at all under the coalition government,
and the reason is that while overseas agents have been receiving some of the
income from UK production, domestic residents’ income from overseas production
has not been increasing by as much. This is a key reason why the UK current
account deficit has been increasing.

In a nutshell, the prosperity of the average citizen in this
country has hardly increased over the period of this coalition government - a
result that is totally unprecedented since at least WWII. As recoveries from
recessions go, this does not seem like a recovery worthy of the name. Yet we
keep being told by mediamacro that the Coalition’s strong card is its economic
record!

Sunday, 26 April 2015

The idea that austerity during the first two years of the
coalition government was vindicated by the 2013 recovery is so ludicrous that
it is almost embarrassing to have to explain why. The half-truths in this case
are so flimsy they do not deserve that label. I can think of two reasons why
that claim could have any credibility. The first is that people confuse levels
and rates or change. The second is that some critics of austerity might have
occasionally overstated their case.

To see the first point, imagine that a government on a whim
decided to close down half the economy for a year. That would be a crazy thing
to do, and with only half as much produced everyone would be a lot poorer.
However a year later when that half of the economy started up again, economic
growth would be around 100%. The government could claim that this miraculous
recovery vindicated its decision to close half the economy down the year
before. That would be absurd, but it is a pretty good analogy with claiming
that the 2013 recovery vindicated 2010 austerity.

The second point is that some critics of austerity did on a few
occasions allow their rhetoric to get the better of them, and suggested that if
austerity continued a recovery would never come. That was always an
overstatement. It became particularly inappropriate because, as I noted in my
last post, fiscal contraction did pause in 2012. But serious analysis should
not be about rhetoric, or as Paul Krugman notes about passing off perception as
reality. (Sometimes in my rather British way I think Paul is a little too
combative with those he might have a chance to persuade, but I’m in 100%
agreement with him here.)

What any knowledgeable and honest media reporting should have
done is tear the vindication argument to shreds. It should have asked what contribution fiscal austerity made to the
slowest recovery from a recession for centuries. That would be an honest
debate. No doubt there are factors behind the delayed recovery that the
government were powerless to influence, like a weak banking sector for
instance. But if the banking sector is unable to support an expanding private
sector, which in a recession isn’t too keen on expanding anyway, you have no
business throwing public sector employees out of jobs. [1]

[1] And please, before anyone comments about how fast employment has grown, look at the data for unemployment - it went up in 2011. The deeper problems with the 'didn't we do well on employment' line will be addressed in the penultimate post in this series.

Saturday, 25 April 2015

I’ve been relieved that my earlier analysis of the various post poll
options seems to accord within a seat or two with what the experts are now saying. Remember nothing
should be taken for granted: Electionforecast.co.uk (the group the
legendary Nate Silver has teamed
up with) still thinks there is around a 5% chance that the
Conservatives win outright. But if we ignore that possibility, the key numbers
will be near these:

If the seat count is close to 290, Cameron continues only with
the support of a few UKIP MPs and the DUP. (In my view, we should be much more
worried about a government dependent on the DUP than a
government dependent on the SNP.)

Zone B: In between M and C,
where Lab+SNP get between 290 and 315 seats, where it is all down to the Liberal Democrats.

This analysis by Harry Lambert is excellent in
detail, but I think the overall gloss that Miliband is now the favourite is
misleading if you read the text. Labour needs all the seats in which it is
currently favoured, plus a few surprises. Electionforecast currently have the
most likely outcome as Lab+SNP=315, which means we are just in Zone B.

My instinct was always that Clegg wanted to go with Cameron,
and as each day passes this becomes much clearer. But that does not mean he will
get his wish, if Labour plays its cards right and LibDem members have any
influence on their party. The reason is that in terms of policy, and party
members, the LibDems are nearer Labour than the Conservatives. Clegg would talk
to the Conservatives first, and just as last time he will play it such that
this coalition appears to be the only option. He can use the following three
arguments:

1)The Conservatives have more seats than Labour (which
assumes the SNP do as well as predicted). If Con>Lab+SNP this will carry
some weight; if not less so.

2)Not working in a government dependent on a party that
wants to break up the UK. I think this is a highly undemocratic argument,
one that can ironically only hasten the break-up of the UK, and it becomes
particularly odd if the alternative is a government dependent on the DUP.
Incidentally it is also a stance that does the LibDems no favours in trying to
keep (or ever win back) their Scottish seats.

3)Labour are not offering such a good deal.

What Labour can do is try and pre-empt this last argument by
(if necessary) making the deal they are prepared to do public, so that the
party sees what is on offer. Which means they need to think this through before 7th May.

In the end the LibDems got nothing from their current coalition
on voting reform, and Labour could offer them something for sure. Not having to
worry about a European referendum would also be attractive to the LibDems, particularly as Cameron could well advocate leaving.
Labour could also be flexible about the type of arrangement: it could be a
formal coalition, or it could be simply an understanding (that Miliband should
be PM), but otherwise the LibDems vote on issues as their manifesto dictates.
If they lose a lot of seats, that last option may appear attractive,
particularly if the party is strongly divided over continuing with the
Conservatives. There is also a strong argument that continuing in coalition
with the Conservatives will bring about their eventual demise.

However, despite all this, to go with Labour would involve
rejecting their current leadership’s advice (and maybe therefore their current
leadership), and I suspect that will be too much for them in the end. Having
helped them win a seat in the past, I hope I’m wrong.

People should by now know the Orwellian character on this
government’s spin enough to suspect that if they keep on asserting something,
it is almost certainly not true. So it is with the idea of the ‘long term
economic plan’. Here is a chart of the original plan for the deficit, and what
has actually happened.

The government kept their word on reducing the deficit in
financial years 2010-11 and 2011-12, in part through sharp reductions in public
investment: cancelling repairs to schools, reducing spending on flood defences
etc. But that helped kill the recovery, so they allowed deficit reduction to
stall.

The 2010 plan put the pace of deficit reduction at the centre
of policy making, and the data make it clear that in 2012 the plan changed.
Why did mediamacro not call this for what it was. There are two half-truths
here. First, austerity in terms of squeezing lots of government departments
continued. Welfare reform continued to cause plenty of misery, and food banks
continued to grow. So in that very visible sense, the policy of squeezing the
state was not abandoned. Second, the Chancellor’s main fiscal rule allowed him
to delay austerity in this way (because the form of the rule, since abandoned,
was sensible in that respect), so in that sense
there was no dramatic change. However in terms of the deficit numbers, fiscal austerity was put on hold in 2012.

Not making it clear that the plan had changed was a
serious failure. If that call had been made, the Chancellor would have had to
account for why he had allowed deficit reduction to stall, and that in turn
would have established quite clearly that previous austerity had delayed the
recovery. Failure to make that call allowed (and continues to allow) the
Chancellor to pretend that the delayed recovery was not his fault, when it so
clearly was. (Some journalists also got sidetracked in focusing on OBR
forecasts, rather than on the OBR’s assessment of the impact of austerity.) Finally not saying that the plan had changed encouraged the ludicrous claim that the 2013 recovery vindicated austerity, which is tomorrows myth.

So this is why the Chancellor keeps on talking about his ‘long
term economic plan’, because to admit he changed his plan (as a sensible
reaction to the delayed recovery) would open the door to questions about why
the plan had changed, and therefore about the damage that austerity had done.
It that sense the ‘long term economic plan’ is a key part of the mediamacro
myth.

Friday, 24 April 2015

Philip Stephens in the FT says the idea that a Labour-SNP understanding
would amount to Labour being held hostage by the SNP is nonsense. He is of
course correct. In a vote on any particular issue, 50 odd SNP MPs could hardly
impose their will on 600 MPs from other parties. More interesting is what this
line tells us about the media, about the current Conservative Party, and about
what the future might hold if they remain in power.

First the media. In my continuing series on mediamacro, I
stress that myths are best based on half-truths. Half-truths are the grain of
truth on which you can erect a huge lie. With the SNP and Labour, the
half-truth is that SNP views on an issue could perhaps weigh a little more
heavily on Labour than, say, the views of UKIP, because UKIP will always vote
to bring down a minority Labour government, but the SNP will not. That fact
will never make Labour go where it does not want to go, but at the margin it
could nudge it a bit more in one direction. Conceivably, we might get a bit
less austerity, we might treat welfare recipients a bit more humanely - that
kind of thing. But would we get some policy that was against the interests of
the rest of the union? Of course not. Colin Talbot makes it clear how limited
the SNP’s power would in practice be here. [1]

With mediamacro, you generally need some expertise, or some
knowledge of the data, to see that the half-truth is very far from the myth,
knowledge political commentators may not have. In the case of ‘SNP blackmail’,
political commentators have the required knowledge more than most. So for me
the success of the scaremongering about a minority Labour government will be an
interesting test: is lack of economic expertise or knowledge important in
explaining mediamacro, or is control of the majority of the UK press
sufficient. There are signs that the scaremongering is working.

As Lord Forsyth (former Scottish secretary in a Conservative
government) said, his own party is putting electoral
tactics above a historic commitment to the defence of the UK union.This can hardly come as a surprise. The
Scottish independence referendum was a close run thing, so you might expect a
party with the integrity of the nation at heart to tread carefully in the
subsequent days and months to heal wounds. Instead, Cameron chose in the
morning after the vote to attempt to wrong foot Labour on ‘English votes on
English issues’, saying: "We have heard the voice of
Scotland and now the millions of voices of England must be heard." It was
a gift to the SNP.

What does all this tell us about the Conservative Party? Does
it tell us that it secretly wants the SNP to get so strong that it could win a
future referendum and break up the union? No, what it tells us is that this is
a party that is prepared to take large long term risks for minor short term
political advantage. As I have suggested on a number of occasions, that seems
to be a common pattern in its macroeconomic policy (premature deficit reduction
and Help to Buy being two obvious cases).

One of the clearest examples of this is our relationship with
Europe. The decision to hold a referendum was taken to appease the right in his
own party and potential UKIP voters, even though the uncertainty it creates
will damage the economy and even though there is no chance that Cameron will be
able to renegotiate to any significant extent. But large sections of what we
might call the Establishment seem unperturbed as long as it helps return a
Conservative led government. The assumption seems to be that Cameron will be
able to sort things out when the time comes, and it will be business as usual.
As Polly Toynbee puts it, the view is that “Cameron is “one of
us” so he’ll somehow secure an “in” result for his 2017 referendum”

This ignores all the evidence about party before country. A
Cameron recommendation to stay in the EU will split his party: after the
election a majority of MPs may favour leaving, and a majority of party members already
do. In two years time, all the senior figures in the party will be thinking
about the elections for Cameron’s replacement. (This is why Cameron’s announcement
that he would step down before 2020 was so significant.) In this situation,
what are the chances that Cameron will either be equivocal or recommend exit
(leaving his successor to negotiate what they can in the way of trade deals)?
In that case, what are the chances of the electorate voting to stay in, when
the right wing press that helped win the 2015 election for the Conservatives
will be in full cry to leave? I would be foolish to say that exit was a
probability, but I would be just as foolish to assume that the risk of leaving
was small.

Voting for a political party that repeatedly puts itself before the
national interest is not a good call in the best of times. When it could
influence our position in Europe and even the Union itself, it becomes a huge
mistake. Too many in the UK seem prepared to walk into that minefield, for the
sake of avoiding what would be the mild inconvenience for them of a Labour led
administration.

[1] I doubt very much that it will make any Labour government
give additional preferential treatment to Scotland. The opposition will cry
foul on this if that ever happened (and probably sometimes when it does not).
As a result, Labour will go out of their way to avoid such an outcome. Would
the SNP bring down a Labour government just because they failed to get some
minor fiscal advantage? I think that is also highly unlikely. What the SNP will
fear most is being seen as the party that brought down a Labour government and
helped their opponents into power.

In previous posts in this series (0,
1,
2,
3)
we have established that the large increase in the deficit in 2010 was a
consequence of the recession and not Labour profligacy - the Labour government
was clearly not profligate - and that this deficit was not causing any panic in
the financial markets. But surely it is a good idea for the government to
tighten its belt when it runs a large deficit, just as individuals who spend
more than they earn need to take action? Mediamacro is fond of drawing this
analogy.

The first point to clear out of the way is that individuals do
not always try and ‘balance their books’. People generally spend more around
Christmas, and make up any deficit through the rest of the year. You can think
about deficits and surpluses that are just the result of the normal economic cycle in
a similar way.

As the 2010 deficit was a consequence of the recession, can we
therefore assume that it will correct itself as the economy recovers? The
answer depends on the extent of the recovery. If we returned to the
pre-recession trend level of output then roughly yes [1], but not many
economists think that is likely. Instead organisations like the OBR assume that
much of the impact of the recession on output will be permanent. We can call
the additional deficit that arises from this permanent loss of output
‘structural’. The structural deficit will not go away without some government
action.

A good rule for an individual with a ‘structural deficit’ is to
take action to correct it sooner rather than later, particularly if there are limits to their ability to borrow. Our mediamacro myth is that
the same applies to governments: the 'maxing out the national credit card' idea. This is something that every economics student
learns is wrong in the first year of their studies. Cutting the
government’s deficit reduces aggregate demand, which reduces output. An
individual that cuts their spending does not need to worry about the impact
their decision will have on the rest of the economy, but the government because
it is so large does have to think about this. When the government is free to borrow more at no extra cost (which we have seen that in the UK it was), then it has an important choice about when to start reducing its deficit.

Is there ever a good time to reduce the
deficit, if output will always take a hit? There are two reasons why some times are much better than others. First, there is now quite a lot of evidence that cutting deficits in a
recession has a larger impact on output than cutting deficits at other times (see here and here).
Second, theory tells us that cutting deficits need not in principle harm the economy at all if
monetary policy can offset their deflationary impact. If the Bank of England
can cut interest rates at the same time as the government cuts its spending,
the net effect on the economy could be zero.

This is a crucial point. Indeed it is the half-truth on which
the coalition’s policy of immediate austerity seems to have been based. Modern
mainstream macroeconomics says that in
normal times governments do not need to worry about the impact their fiscal
decisions (like austerity) will have on the economy, because monetary policy
will offset that impact. In a speech to the RSA in 2009 this was the idea that
the future Chancellor put
at the centre of his macro strategy.

There was only one problem, which turned out to be extremely
serious. Just before he made that speech, UK short term interest rates hit
0.5%, and the Bank of England decided they could be cut no further. They had
reached what economists call the ‘Zero Lower Bound’, sometimes described as a
liquidity trap. As a result conventional monetary policy was unable to offset
the deflationary impact of austerity, and 2010 austerity killed the recovery
that seemed to have just started. We had to wait until 2013 for a period of
sustained output growth. The Bank did have some unconventional policies that it
tried - most notably Quantitative Easing - but as it had no idea how effective
these were, they were hardly an adequate substitute for cuts in interest rates.

Was the problem of nominal interest rates hitting a floor and
therefore not being able to offset the impact of fiscal austerity on output
something economists had not foreseen? Is that why the Chancellor ignored this
possibility in his 2009 speech? Far from it! Keynes had dealt with the problem
in the Great Depression in the 1930s. More recently, the same problem had
arisen in Japan in the 1990s. By 2009 a large number of articles had been written
about this problem, which is why economists like Paul Krugman and myself were
such strong critics of fiscal austerity the moment it was proposed.

Most mediamacro myths in this series just need a look at the data and common sense to bust. In those cases it is natural to look at the media itself for the source of the mediamacro problem. In this particular case busting the myth requires some (entirely conventional) macroeconomics. The fact that this macroeconomics has not found its way into political discussion of fiscal policy may reflect other problems in the knowledge transmission mechanism, including the fact that outside the US central banks seem very reluctant to acknowledge the severity of the Zero Lower Bound/liquidity trap problem.It is difficult to overstate the consequences of this. As we have seen, the prospective Chancellor in a 2009 speech setting out the theoretical framework behind his policy ignored the problem, even though it was in front of his eyes. Each household in this country lost on average at least £4000 as a result. Yet incredibly, the same person proposes to make exactly the same mistake after 2015, and it is largely left to a few academic bloggers to point this out.

[1] Not a complete yes, because although the deficits caused by
this kind of recession would be temporary, they will have raised the level of
debt, and the interest on that debt will add to future deficits. We can only
ignore that if we soon expect a future boom of equal magnitude, which would be
an unwise thing to do.

Thursday, 23 April 2015

Everyone agrees that the UK Institute of Fiscal Studies is
great. It is perhaps best known for its commentary of macro budgetary issues,
but it does a great deal of detailed top class research into the micro impact
of different forms of taxation, and much
more. Today it released its assessment of the different political parties’
plans for spending and taxation policy after the election. It makes two very
important points: that the Conservatives plan much greater cuts than the other
parties, and that there are important gaps in how much each party have told us
about how they will achieve their aggregate plans (with probably the biggest
‘black hole’ with the Conservatives, although do not expect to hear that
comment on the BBC).

At the same time as reading this document, I was also writing
my next macromedia myths post, where I complain about the lack of media
exposure given to the problem of the liquidity trap or Zero Lower Bound, and
why this problem is central to the critique of austerity during a recession. So
I thought I would just check that these terms appeared somewhere in the IFS
document. They do not. All I can find is this paragraph:

“A lower level of borrowing would imply debt falling more
quickly. This would have the benefits of leading to a lower level of debt
interest payment and potentially leaving the UK better placed to deal with any
future adverse event (such as the public finance challenge posed by an ageing
population or any future recession). But reducing debt more quickly would also
require more in the way of tax rises and/or spending cuts.”

If I have missed a section where the risks of rapid deficit reduction
when interest rates are still so low are discussed, I shall remove this post. But
if such a discussion is indeed absent, I think I can reasonably complain. Why
has the IFS chosen to go long on numbers, and short on ideas? Their analysis is
a key resource for the media, and so if the IFS do not even mention such basic
macro points when discussing macro policy, it becomes a little less surprising
that the media also ignores them.

I have always tried to emphasise that I regard the mediamacro
problem as a system failure, rather than a problem with particular newspapers
or journalists or editors. I have also tried to stress that I remain unclear as
to what the critical drivers of this problem are: a biased print media, the
role of the City or something else. That something else could potentially
include, at least in the UK, the way academic ideas fail to be transmitted to
the media by academic think tanks.

The only way you can sustain the myth that Labour was fiscally
profligate is by suggesting that immediately before the recession the UK was
experiencing a massive boom. In an economic boom tax receipts are high and
spending on transfers low, so the budget should be in surplus. If it is in fact
in significant deficit, that indicates serious fiscal laxity.

There are two half-truths here. First, everyone remembers talk
of a housing boom, and a housing boom sounds pretty similar to a more general
economic boom. But more seriously, the idea that there was a huge boom in 2007
appears to be backed up by data from the IMF and OECD. Let us take each in
turn.

This chart of house prices clearly shows a housing boom in the
middle of the last decade. But does it indicate a general economic boom in
2007? There are two problems: there is clearly an underlying trend in the data,
and house prices rose most rapidly at the beginning of the decade. When you
take any trend into account, the middle years of that decade look like a
plateau.

The upward trend in house prices is likely to be due to two
factors: a growing mismatch between demand (encouraged in part by inward migration)
and supply (very few new houses being built), and lower real interest rates.
(The reason why low rates are important is explained here, and the link with demand and supply here.) As all these factors can also vary in
the short term, this indicates that the house price cycle need not always be
correlated with the more general economic cycle. The clearest indication of
this is what has happened to London and South East house prices over the last
two years, which are now well above 2007 levels. Does that mean the region is
in the middle of an even more massive boom? Of course not.

If you look at both the OECD and IMF’s current measures of the
output gap (the difference between actual output and the level that would keep
inflation constant), they suggest a large positive gap for the UK in 2007.
(3.5% in the latest OECD Economic Outlook.) That is a pretty large boom. The
problem here is that in 2007, the OECD only thought the output gap at the time was
less than 0.5%, which is no boom at all. Why the change in view? The answer is
the recession, and the UK’s slow recovery. To cut a long story short, the OECD
in effect retrospectively fit a gradually moving trend through the data (for
productivity rather than output, but it comes to the same thing), so the longer the UK
fails to catch up with its pre-recession trend, the more the OECD has to bend
that trend over the past. The more it bends the trend, the more 2007 looks like
a boom.

Could the OECD be right now and wrong back in 2007? The big
problem here is that none of the more reliable measures behaved in 2007 as you
would expect in a large boom. Inflation was happily bobbing around the Bank’s
2% target. Interest rates were rising, but not rapidly. Unemployment was a
little higher than a couple of years before. Consumer debt was rising, but mainly because of rising house prices and
mortgages. As the Bank’s Ben Broadbent points out, in the subsequent recession
“losses on most domestic loans have actually been unexceptional. Instead, it is
UK banks’ substantial overseas assets that caused much of the damage.”

This gets us to the key point as far as Labour profligacy is
concerned. What is relevant to this issue is not what we think about the 2007
UK economy today, but what the general consensus was at the time. As we have
already noted, the 2007 OECD Economic Outlook thought at the time that the UK
economy was pretty close to trend. As far as I can see, this was a consensus
view. The IFS Green Budget for 2007 had an output gap of
effectively zero. The IMF’s Article IV assessment published around Budget
time in 2007 came to a similar conclusion. The reason this was the consensus
view is the data noted in the previous paragraph.

One final look at the numbers. If we assume real growth of 2.5%
(again a consensus view at the time) and 2% inflation, then a debt to GDP ratio
of 40% would imply that the sustainable deficit was 1.8% of GDP. As the
estimate of the output gap at the time was around zero, there was no reason to
adjust this for the state of the cycle. The actual deficits for financial years
2006-7 and 2007-8 were slightly over 2.5% of GDP. The difference is what I call
mild imprudence, and would have been fairly easily to correct in subsequent
budgets. By 2009-10 the deficit had risen to 10.2% of GDP because of the
recession. So the deficit in 2010 was a consequence of the recession, not
Labour profligacy before the recession.And if you cannot shake off that idea that Gordon Brown was profligate, one final set of figures. Between financial years 1979 to 1996 (the 18 years of Conservative government), the deficit averaged 3.2% of GDP. From 1997 to 2007 it was 1.3%. Now maybe the Conservatives were a bit unlucky with having two recessions on their watch, so the equivalent cyclically adjusted figures are 2.6% and 2.1%. One last time: Labour fiscal profligacy is as mythical as the unicorn.

Wednesday, 22 April 2015

Judging by pageviews, my most widely read post ever was on Scottish independence, and
its title was ‘Scotland and the SNP: Fooling yourselves and deceiving others’.
I was extremely critical of the fiscal claims made by the SNP. I wrote

“There are many laudable
reasons to campaign for Scottish independence. But how far should those who
passionately want independence be prepared to go to achieve that goal? Should
they, for example, deceive the Scottish people about the basic economics
involved? That seems to be what is happening right now. The more I look at the
numbers, the clearer it becomes that over the next five or ten years there
would [be] more, not less, fiscal austerity under independence.”

That was half a year ago, and of course lower oil prices have
only strengthened that view. But more recently it has been refreshing to hear Nicola Sturgeon make the
case against UK austerity. So when I was asked by The Conversation to fact check
this statement by her:

“In the last five years,
austerity has undermined our public services, lowered the living standards of
working people, pushed more children into poverty and held back economic
growth.”

“Nicola Sturgeon’s
statement on the economic impact of austerity on the UK is correct, with no
qualifications.”

Today the SNP put out a press release on the Conversation report.
Unfortunately it contained the following comment from Stewart Hosie, Deputy
Leader of the SNP and Treasury spokesperson:

''Professor Wren-Lewis
reflects what many other experts and indeed members of the public know all too
well - that Tory/Lib Dem austerity has done deep harm to the country's recovery
from the Labour recession.”

Oh dear – ‘the Labour recession’. That would be the global
financial crisis that originated with US subprime mortgages! Calling this the
Labour recession is just stupid, and is something I would never say. It is very unfortunate (and I hope
it is just a misfortunate) that Stewart Hosie appeared to suggest that I had
said or implied that. Whatever the intention, it indicates that at least some
in the SNP are still in the business of making highly misleading statements to
advance their cause.

While on the subject of the SNP and this election, let me make
one final point, just in case any prospective SNP voters read this. In the
quite likely event that the Conservatives get more seats than Labour, but less
seats than Labour and the SNP combined, in a situation where either side would need
LibDem support Nick Clegg has made it clear he will talk to the Conservatives
first. That will almost certainly lead to the current coalition
government continuing. Clegg’s reasoning for doing this makes little sense, but the SNPcannot influence Clegg’s decision, and I suspect nor can his party even if
they were minded to.

If that comes to pass, then every vote for the SNP rather than
Labour that loses Labour seats becomes a vote to continue with the current
government. That is not an opinion, but a factual statement. So, to be consistent with his own logic, I think Stewart
Hosie would have to call this election result the SNP’s Tory-LibDem second term.